Showing papers on "Financial risk published in 1995"

The Global Financial System: A Functional Perspective

Abstract: Leading financial scholars present essays examining the performance of the basic financial functions underlying global financial systems: payments, lending and investing, pooling funds, allocating risk, providing information, and dealing with incentive issues - with particular emphasis on how their performance is changing and implications for the future.

The Influence of International Risk on Entry Mode Strategy in the Computer Software Industry

Abstract: Introduction As the business world becomes more global and the level of international competition continues to increase, managers will find themselves facing increasingly complex strategic decisions. Perhaps first and foremost among these decisions are the decisions relating to methods of expanding the firms' international operations. However, as one considers the prospects of international expansion one can not help but be aware of the many and varied risks facing firms in these "strange new lands." Ghoshal (1987) has postulated that managing risks is one of three strategic objectives for managers of multinational firms. Yasai-Ardekani (1986) has suggested that industry environmental characteristics such as risk, influence management perception which, in turn, leads to an influence on the structure of the organization. Carman and Langeard (1980) have stated that service firms face far greater risks in international expansion than do product firms: (1) the inseparability of production and consumption for services eliminates certain entry mode choices, (2) the lack of visibility of services (intangibility) increases the time needed to diffuse service innovation, and (3) service providers may be perceived by host governments as contributing little to the national economy while draining resources, precipitating regulations that favor domestic service providers over foreign providers. Existing research has shown a relationship between risk and international diversification, i.e. how firms can reduce overall financial risk by diversifying into international markets (see Rugman 1979 for a discussion). Risk has also been shown as a motivation for international expansion, e.g. entry into competitor markets as a bargaining tool through the "exchange of threats" (Casson 1987, Graham 1985, Vernon 1985, Vernon 1974). In addition entry mode research has included "risk" as$a key element in many of their studies of entry mode determinants (Root 1987, Anderson and Gatignon 1986, Hennart 1988, Contractor 1990, Buckley and Mathew 1980). Vernon (1985) and Miller (1992) have suggested that the perception of a more comprehensive "international" risk and the strategic choice of entry mode may be related. They suggest that looking at individual international risks, such as exchange rate or political risks, in isolation of the other international risks results in an incorrect analysis of the internalization question and can lead to an incorrect entry mode choice. This study is part of a more expansive research project designed to measure perceived risks in different parts of the world and relate these risk perceptions to the strategic choices made by managers. To focus in on the risk-strategy relationship, we first identify key components of the international risks involved in strategic decisions making and then we explore ways in which management can minimize the impact of these risks on the firm through the strategies, i.e. entry mode selected. Once a theoretical base is formed, we present the results of a pilot study to test the risk-entry mode relationships, using a small sample of international high-tech service firms. Whet is International Risk? Both Miller (1992) and Vernon (1985) refer to international risk, however only Miller provides details of a three part integration of international risk variables. The three parts consist of (1) general environmental, (2) industry, and (3) firm-specific risks. General environmental uncertainty refers to those variables that are consistent across all industries within a given country. Included in this factor are such variables as political risk, government policy uncertainty, economic uncertainty, social uncertainty, and natural uncertainty (uncertainty caused by nature itself, such as floows or typhoons). Miller's second grouping, industry uncertainty, contains the risks associated with differences in industry/product-specific variables. Among these variables are the input market uncertainties associated with production inputs, such as material/labor supply availability, quality, and quantity. …

Default risk insurance and incomplete markets

Abstract: This paper uses the existence of secondary markets for debt instruments with default risk (e.g. corporate bonds) to define default insurance along the lines of financial economics. It examines whether, in the case of several risk-neutral measures, characteristics of default can be uniquely determined by the prices of contracts involving default-prone securities.

Real estate is not normal: A fresh look at real estate return distributions

Abstract: Investment risk models with infinite variance provide a better description of distributions of individual property returns in the Russell-NCREIF data base from 1980 to 1992 than normally distributed risk models. Real estate investment risk is heteroscedastic, but the characteristic exponent of the investment risk function is constant across time and property type. Asset diversification is far less effective at reducing the impact of nonsystematic investment risk on real estate portfolios than in the case of assets with normally distributed investment risk. Multirisk factor portfolio allocation models based on measures of investment codependence from finite-variance statistics are ineffectual in the real estate context.

The Influence of Risk Diversification on the Early Exercise of Employee Stock Options by Executive Officers

Abstract: This paper examines the decision to exercise employee stock options (ESOs). Our results indicate a positive relation between the extent of "early" exercise and the unhedged risk of the option. Specifically we document a positive relation between the variance of ESO returns and the extent of "early" exercise and show that the strength of the relation is reduced by the extent the firm hedges the returns on the ESO. We thus provide empirical evidence of a link between an ESO's expected term and its investment risk to the executive and document that some firms provide a hedge against option risk.

Managing financial risk : a guide to derivative products, financial engineering, and value maximization

Abstract: The Evolution of Risk Management Products. An Overview of the Risk Management Process. Impact of the Introduction of the Risk Management Products. Forward Contracts. Applications of Forwards. Futures. Applications of Futures. Swaps. Applications of Swaps. A Primer on Options. First-Generation Options. Applications of Options. Second-Generation Options. Engineering "New" Risk Management Products. Hybrid Securities. The Dealer's Perspective. Measuring and Managing Default Risk. Managing Price Risk in a Portfolio of Derivatives. Risk Governance. Risk Management and the Value of a Nonfinancial Firm. Measuring a Nonfinancial Firm's Exposure to Financial Price Risk. Implementing a Risk Management Program. Uses of Risk Management Products by Banks and Other Financial Institutions. Uses of Risk Management Products by Institutional Investors.

Financial Innovation and the Management and Regulation of Financial Institutions

Abstract: New security designs, improvements in computer telecommunications technology and advances in the theory of finance have led to revolutionary changes in the structure of financial markets and institutions. This paper provides a functional perspective on the dynamics of institutional change and uses a series of examples to illustrate the breadth and depth of institutional change that is likely to occur. These examples emphasize the role of hedging versus equity capital in managing risk, the need for risk accounting and changes in methods for implementing both regulatory and stabilization public policy.

Financial factors in the economics of capitalism

Abstract: The conference’s title, “Coping with Financial Fragility: a Global Perspective,” implies that financial fragility is a meaningful economic concept. Its existence, not always but from time to time, is accepted as an attribute of capitalist economies. However the structure of the dominant macro-and microeconomic theories of our time, which are built upon the modern version of Walrasian general equilibrium theory, ignores the financial dimensions of capitalist economies.1 If economic theory is to be relevant, for the intensely financial world in which we live, then an economic theory which fully incorporates financial factors into the determination of the behavior in the economy is needed. Such a theory should not hold that financial factors are “exogenous shocks” to the economy or explain whatever malfunctioning of the economy that takes place as the result of the incompetence of central bankers.2

Financial Indicators and Financial Change in Africa and Asia

Abstract: Deregulation of the financial system often proceeds in tandem with macroeconomic stabilization centered on monetary and other financial targets. This paper presents a model where there may be conflict between these processes. The indicator properties of some financial variables may be rendered unstable by the liberalization process. However, other, carefully selected financial aggregates may contain information about economic activity that is useful to policy makers during stabilization. Data from a group of selected African and Asian countries is examined. These are broadly consistent with the predictions of the model, while highlighting the importance of macroeconomic and financial stability for the success of financial reforms.

Decision making by Scottish bank managers

Abstract: Commercial banks are the major source of external finance for small firms in the UK. Describes a study which was carried out to investigate how bank managers make decisions on lending to small firms. The study looked at adverse selection (i.e. where a manager turns down a good proposal which turns out to be a success) and its effect on small firm liquidity constraints. The researcher took on the role of an entrepreneur and presented a business plan based on an actual lending proposition to bank managers in Scotland. Compares the study with an English study. Findings suggest a more favourable treatment of the proposition by the Scottish bank managers. However, there was variation among banks in the way managers assessed the proposition. There was an emphasis on financial information, gearing and security which reflects the capital‐based approach to bank risk assessment in the UK. Considers policy implications for risk assessment and small firms/banking relationships.

Estimating Policy-Invariant Deep Parameters in the Financial Sector When Risk and Growth Matter

Abstract: THIS PAPER provides and illustrates an approach to the estimation of technology parameters in the financial sector. The relevant technologies are those of the financial intermediaries that produce inside money as output services and the nonfinancial firms that demand financial services as inputs to production technology. We also display analogous results for consumer demand, but without the modeling and econometric details, which are available elsewhere. The problems that we seek to solve through our approach to modeling and Euler equation estimation are the "Lucas Critique" and what Chrystal and MacDonald (1994, p. 76) recently have called the "Barnett Critique." We also explore the tracking ability of the Divisia monetary aggregate and simple sum monetary aggregate relative ta the GMM estimated exact rational expectations monetary aggregate for each type of economic agent. In this paper, we produce and estimate Euler equations for firms that demand or supply financial services as an illustration of the available approach, first advocated forcefully and convincingly for the financial sector by Poterba and Rotemberg (1987) with respect to consumer demand for financial services. We do not seek to integrate the three sectors into a complete economy, in which aggregation blockings would have to conform across sectors. In addition, we do not explore in detail the

Linkages between Financial Variables, Financial Sector Reform and Economic Growth and Efficiency

Abstract: This paper analyzes the different channels through which financial variables and financial sector reform can affect economic growth and efficiency, using panel data for 40 countries which reformed their financial systems. Financial sector reform is hypothesized to affect economic growth and efficiency through three main channels: the real interest rate representing the interest cost of capital, the volume of intermediation, and financial sector efficiency. The results indicate that financial reforms have structural effects; that financial variables and reforms are important determinants of economic performance; that the impact depends on whether countries did or did not face a financial crisis; and that the "quality" of financial sector reform matters.

Financial performance comparison between international joint ventures and wholly foreign‐owned enterprises in China

Abstract: International joint ventures (IJVs) and wholly foreign-owned enterprises (WFOEs) are the two major competing modes of Chinese market entry for foreign investors However, the financial performance of and relative financial efficacy between the two modes have not been researched The present study utilizes firmspecific financial data and examines financial ratios and characteristics of IJVs and WFOEs in the current Chinese financial environment Results of this study reveal that the WFOE is superior to the IJV in terms of asset efficiency, financial risk aversion, and export growth whereas the IJV outperforms the WFOE with respect to local market growth and environment adaptation © 1995 John Wiley & Sons, Inc

Corporate risk tolerance and capital allocation: a practical approach to implementing an exploration risk policy

Abstract: Petroleum exploration companies are confronted regularly with the issue of allocating scarce capital among a set of available exploration projects, which are generally characterized by a high degree of financial risk and uncertainty. Commonly used methods for evaluating alternative investments consider the amount and timing of the monetary flows associated with a project and ignore the firm`s ability or willingness to assume the business risk of the project. The preference-theory approach combines the traditional means of project valuation, net present value (NPV) analysis, with a decision-science-based approach to risk management. This integrated model provides a means for exploration firms to measure and to manage the financial risks associated with petroleum exploration, consistent with the firm`s desired risk policy.

Risk-Based Capital Standards and the Riskiness of Bank Portfolios: Credit and Factor Risks

Abstract: Bank risk-based capital (RBC) standards require banks to hold differing amounts of capital for different classes of assets, based almost entirely on a credit risk criterion. The paper provides both a theoretical and empirical framework for evaluating such standards. A model outlining a pricing methodology for loans subject to default risk is presented. The model shows that the returns on such loans are affected by the complicated interaction of the likelihood of default, the consequences of default, term structure variables, and the pricing of factor risks in the economy. When we examine whether the risk weights accurately reflect bank asset risk, we find that the weights fail even in their limited goal of correctly quantifying credit risk. For example, our findings indicate that the RBC weights overpenalize home mortgages, which have an average credit loss of 13 basis points, relative to commercial and consumer loans. The RBC rules also contain a significant bias against direct mortgages relative to mortgage- backed securities. In addition, we find large differences in the credit riskiness of loans within the 100 percent weight class and potentially large benefits to loan diversification, neither of which are considered in the RBC regulations. We also examine other types of bank risk by estimating a simple factor model that decomposes loan risk into term structure, default, and market risk. One implication of our findings is that although banks have reallocated their portfolios in ways intended by the RBC standards, they may have merely substituted one type of risk (term structure risk) for others (default and market risk), of which the net effect is unknown.

The wealth effects of deregulation of Canadian financial institutions

Abstract: Canada, like other industrial countries, recently introduced various financial reforms to remove the barriers separating the operations and ownership of banks from non-bank financial institutions. This study analyzes the wealth effects of the reforms on the banks and non-bank financial institutions and the changes in their systematic risk resulting from financial deregulation over the period 1984 to 1991. The results indicate that while there was a significant cumulative gain for the insurance industry, unlike a number of U.S. studies, there was no evidence of wealth transfer among the institutions during the period of deregulation of the Canadian financial system. Additional tests indicate that although the regulatory changes did not have a significant effect on the risk of the banks, the systematic risk of the non-bank financial institutions increased significantly during the period of regulatory reforms.

Risk Adjusting Community Rated Health Plan Premiums: A Survey of Risk Assessment Literature and Policy Applications

Abstract: This paper surveys recent health care reform debates and empirical evidence regarding the potential role for risk adjusters in addressing the problem of competitive risk segmentation under capitated financing. We discuss features of health plan markets affecting risk selection, methodological considerations in measuring it, and alternative approaches to financial correction for risk differentials. The appropriate approach to assessing risk differences between health plans depends upon the nature of market risk selection allowed under a given reform scenario. Because per capita costs depend on a health plan's population risk, efficiency, and quality of service, risk adjustment will most strongly promote efficiency in environments with commensurately strong incentives for quality care.

Financial Infrastructure and Public Policy: A Functional Perspective

Abstract: This paper considers the changes in financial infrastructure and regulation necessary to support welfare-improving financial innovation. Topics discussed include the development of a system of risk accounting, the regulation of OTC derivatives, reform of deposit insurance, pension reform and privatization, and the use of financial technology in implementing macro-stabilization policies.

Decision Analysis of Exploration Opportunities in the Onshore US at Phillips Petroleum Company

Abstract: Petroleum exploration managers must allocate scarce resources across a set of risky and uncertain investment alternatives. We developed a decision analysis software package, DISCOVERY, that provided an exploration division of Phillips Petroleum Company an alternative means of evaluating a mix of risky investments and selecting participation levels consistent with the firm’s risk propensity. Managers at Phillips use the software to (1) evaluate projects with a consistent risk-taking policy, (2) rank projects in terms of overall preference, (3) identify the firm’s appropriate level of participation, and (4) stay within their division budgets. This approach increased management’s awareness of risk and risk tolerance and provided insight into the relative financial risks associated with its available investment opportunities. As a result of this project, the company has developed consistent methods of risk analysis that include companywide analysis of all exploration projects.

Quantifying Risk in the Corporate Bond Markets

Abstract: Under certain circumstances, yield spread volatility and total return volatility on corporate bonds are directly related. Consequently, risk in the corporate bond market can be measured by examining yield spread volatility as a function of the credit rating. The EBITDA interest coverage ratio is highly correlated to the market's relative risk levels as a function of the credit rating. Accordingly, market prices are directly influenced by changes in this ratio. Because the EBITDA interest coverage ratio incorporates both business risk and financial risk into one measure, credit analysts and bond investors who wish to identify value in the corporate bond market should strive to forecast trends in this dynamic ratio.

Management of Financial Institutions

Abstract: Part 1 Financial institutions - functions, regulation and structure: overview of financial institution management functions performed by financial institutions financial institutions- an overview regulation of financial institutions globalization of financial markets and institutions. Part 2 Financial analysis and planning: financial statements of financial institutions performance analysis for financial institutions planning for financial institutions. Part 3 Managing credit risk: credit risk analysis evaluating loan and investment risk managing bad loans and investments. Part 4 Managing interest rate and foreign exchange risk: determinants of interest rates valuation of financial claims futures, options and swaps measuring interest rate risk managing interest rate risk foreign exchange risk management. Part 5 Asset/liability management: liquidity managemet asset management and pricing liability management and pricing non-interest sources of income. Part 6 Financial institution managerial finance topics: financial product distribution channels mergers and acquisitions.

Probability and Statistics Applied to the Practice of Financial Risk Management: The Case of JP Morgan's RiskMetrics™

Abstract: RiskMetrics was unveiled by JP Morgan in October of 1994. RiskMetrics is JP Morgan's risk management product that is based on the bank's methodology for the management of financial risk. The methodology specifies an approach to quantifying market risk for the purpose of managing and controlling financial risk in trading, arbitrage, and investment activities. This paper describes the application of probability and statistics in RiskMetrics with the purpose of identifying problems for further research, attracting statisticians to this line of investigation, and establishing a framework for collaboration with financial economists and managers of financial risk. The discussion centers on the four applications of probability and statistics in RiskMetrics : 1) the statistical analysis of returns in the estimation of market risk, 2) the time series properties and statistical description of volatility, 3) the treatment of risk and optionality, and 4) a methodology for mapping financial instruments that relies on the CIR model for the term structure of interest rates. Included in the paper are suggestions for future research. Also included is a summary of the RiskMetrics product and a glossary of risk management terms.

Essential financial management

Abstract: Financial management and the business environment financial analysis financial planning inventory and cash management accounts receivable management short-term financing the time value of money - single payments the time value of money - series of payments bonds stock valuation capital budgeting special problems in capital budgeting leverage and risk risk and required rate of return the market price of risk capital structure dividend policy international financial management.

Strategic responses by hospitals to increased financial risk in the 1980s.

Abstract: OBJECTIVE. This research addresses the following types of responses by hospitals to increased financial risk: (a) increases in prices to privately insured patients (testing separately the effects of risk from the effects of "cost-shifting" that depends on level of Medicare payment in relation to case mix-adjusted cost); (b) changes in service mix offered and selectivity in acceptance of patients to reduce risk; and (c) efforts to reduce variation in resource use for those patients admitted. DATA SOURCES. The database includes a national panel of over 400 hospitals providing information from patient discharge abstracts, hospital financial reports, and county level information over the period 1980-1987. STUDY DESIGN. Econometric methods suitable to panel data are implemented, with tests for pooling, hospital-specific fixed effects, and possible problems of selection bias. PRINCIPAL FINDINGS. The prices paid by private insurers to a particular hospital were affected by the changes in risk imposed by Medicare prospective payment, the generosity of Medicare payment, state rate regulation, and ability of the hospital to bear risk. The risk-weighted measure of case mix did not respond to changes in payment policy, but other variables reflecting the management of care after admission to reduce risk did change in the predicted directions. CONCLUSIONS. Some of the findings in this article are relevant to current Medicare policies that involve risk-sharing, for instance, special allowances for "outlier" patients with unusually high cost, and for sole community hospitals. The first type of allowance appears successful in preserving access to care, while the second type is not well justified by the findings. State rate regulation programs were associated not only with lower hospital prices but also with less risk reduction behavior by hospitals. The design of regulation as a sort of risk-pooling arrangement across payers and hospitals may be attractive to hospitals and help explain their support for regulation is some states.

Financial risk management

Abstract: Exposure to risk and diversification forecasting market movements forwards and futures options options pricing and hedge ratios managing equity risk managing bond risk managing interest rate and currency risk conclusions - who needs to hedge?